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Vallabh Sambamurthy & Robert W. Zmud

Guiding the Digital Transformation of Organizations - Second Edition

© 2017 Legerity Digital Press

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ISBN 978-0-9857955-9-7

Digitalized Business Models for Network Ecosystems

Chapter

06

Guiding the Digital Transformation of Organizations By Vallabh Sambamurthy and Robert W. Zmud

Second Edition Copyright © 2017

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ISBN 978-0-9857955-9-7

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Chapter 6. Digitalized Business Models for Network Ecosystems

Today, when you use your smartphone or tablet to post content on Facebook

statuses, to tweet, exchange photos, or search for information on the Internet, you

expect these types of Internet-based services to be provided mostly free-of-charge.

In economic terms, this amounts to a vast consumer surplus being provided by

organizations offering such services. Why do organizations (e.g., Facebook, Twitter,

WhatsApp, Google, etc.) offer these free services? The not-so-subtle answer is quite

straightforward – to generate revenue streams (via advertising or access fees) by

enabling other organizations to touch an expanding network of consumers or to gain

access to information about these consumers.

But, how does this occur? Most often, it occurs through the creation of a

network (market-focused) ecosystem, with the core transaction of the market being

the free service: a Facebook post, a Twitter tweet, a WhatsApp photo-share, or a

Google Internet search. The core transaction of a network ecosystem is the

primary market exchange activity driving both producers and consumers to an

ecosystem’s market platform. The market platform of a network ecosystem is the

organized collection of digital and business platforms that hosts the content and

functionalities that establish, operate and govern the ecosystem’s market. In order

to better grasp the nature of a network ecosystem, let’s take a closer look at Google

and Facebook. Also, for the ease of understanding, we will refer to the networks

being brought together within a network ecosystem as communities.

The core transaction enabled by Google is a consumer’s search for specific

content (some unit of information) believed to exist on one or more producer websites

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(see Figure 6-1). Note especially the third community involved with Google’s

ecosystem: advertisers. Having developed state-of-the-art search algorithms and an

innovative auction scheme for selling advertising associated with specified search

outcomes, Google has built a business model that profitably monetizes Internet

search by attracting large customer and advertiser communities. Interestingly,

considerable overlap does exist across the three communities interacting through

Google’s search platform: website producers and advertisers do Internet searches

(that is, act as consumers), website producers do advertise, and advertisers do place

content on websites.

Figure 6-1

Google’s Network Ecosystem

Consumers Seeking

Information

Advertisers Producers of Websites

• Relevant, useful information

• Ease of use • Access from anywhere

• Increased traffic • Revenue opportunities • Access to network of

advertisers

• Access to network of potential buyers

• Measurable ROI on ads • Precise campaign control:

pay for clicks

Google’s Market

Platform

The core transaction enabled by Facebook is a person’s posting of content

(accompanied by Facebook immediately notifying the consumer’s friends of the

posting). As depicted in Figure 6-2, the person posting content is a member of a

producer community and the friends wishing to see the posted content are members

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of a consumer community. Somewhat unique to social media sites, these consumer

and producer communities essentially overlap their memberships (aside from pure

lurkers within the consumer community). Note also that Facebook’s ecosystem

involves two additional communities: advertisers and Facebook App producers.

Facebook generates revenue streams from these advertisers and App producers.

Figure 6-2 Facebook’s Network Ecosystem

Consumers Seeking Content

Advertisers Producers of Content

• Relevant, useful content

• Ease of use • Access from

anywhere

• Increased traffic • Revenue opportunities • Access to network of

advertisers

• Global audience of potential buyers

• Measurable ROI on ads • Precise campaign control:

pay for clicks

Facebook’s Market

Platform

Producers of Facebook

Apps

• Access to networks of consumers & producers

• Revenue opportunities

• Access to network of advertisers

This chapter introduces intuitive ways of thinking about network ecosystems

and about the digital and business platforms used to orchestrate the market spaces

established by network ecosystems. The following topics are covered:

 Why Network Ecosystems Exist

 Crowd-Based Capitalism

 Digitalizing Network Ecosystems

 Blended Organizations

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Why Network Ecosystems Exist

In explaining the economic concepts that underlie network ecosystems, we use

the example of a simplified hypothetical social media ecosystem (see Figure 6-3).

Here, community members take on the roles of producers and consumers in order to

share content. By sharing content – and, hence, gaining exposure to each other’s

likes, dislikes, experiences and perspectives - members enrich their relationships

with each other. What is the value proposition that drives a person to join,

participate, and remain in a social media ecosystem? It is the promise of more-

intensively sharing content with individuals with whom a personal relationship

already exists or of sharing content with individuals with whom no (or, at best, a

casual) personal relationship currently exists, but with whom a richer personal

relationship is desired.

Figure 6-3 Simplified Social Media Ecosystem

Consumers Seeking Content

Producers of Content

Social Media

Platform

Social Media Community

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This social media ecosystem value proposition is driven by what economists

refer to as network effects. Stated simply, as the social community grows linearly,

the number of possible relationships amongst the community’s members grows

exponentially: 1 member - 0 possible relationships, 2 members – 1 relationship, 4

members – 6 possible relationships, 12 members – 66 possible relationships, 100

members – 4,950 possible relationships, and so on. Bigger networks, as a general

rule, are more valuable to participants; thus, network effects give network

ecosystems with the largest participant communities an advantage that is hard for

competitors to overcome. We explore network effects further, starting with two-

sided markets, moving on to multi-sided markets, and concluding with a discussion

of winner-take-all markets - the competitive endgame of a market-focused network

ecosystem.

Network Effects

Network effects, or what economists term a network externality, refer to

situations where the worth of or demand for a value-unit grows as an exponential

function of the number of current consumers of a value-unit and/or the number of

complements available to these consumers. A complement increases the perceived

worth of a value-unit. A good example of a complement would be the apps available

for a particular social media ecosystem, e.g., apps that make it easier to manipulate

and share content across the ecosystem. Would you be more inclined to join a social

media ecosystem that had more or fewer of your current friends as participants?

And, is this more likely for larger or smaller social media ecosystems? Now, given

two social media ecosystems comparable regarding the likelihood of you being able

to share content with your friends, would you prefer the ecosystem with more or

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fewer valued complements (e.g., an image manipulation app)? And, would app

producers be more inclined to create apps for larger or smaller social media

ecosystems? This is the power of network effects!

How can firms capture the opportunities available through positive network

effects? Positive network externalities occur only when a customer network is

satisfied with – better yet, enthused about – the value-unit being offered. Much of

Apple’s surge in product success (iPod, iPhone, iPad, iTunes, iMusic, etc.) is a direct

result of positive word-of-mouth chatter. In contrast, negative customer experiences

and perceptions can be devastating.

The competition between HD DVD and Blu-ray as the standard for DVD players

provides an example of network externalities in action. Consider this quote from

Matthew Smith, a former SVP of merchandising for Blockbuster:31 “The consumers

are sending us a message. I can’t ignore what I’m seeing. Blockbuster has been

renting both Blu-ray and HD DVD titles in 250 stores since late last year and found

that consumers were choosing Blu-ray titles more than 70 percent of the time.”

Relatively quickly, word-of-mouth and consumer purchase decisions led to a positive

network effect for Blu-ray titles, subsequent growth in the number of Blu-ray titles

offered for sale or rent relative to the number of HD titles, and Blu-ray ultimately

winning the DVD standards war.

Because of the power of network effects, it is critical for network ecosystems

to exploit the influence of word-of-mouth and enlist their communities in growing

both community membership and member participation within a community.

31 R. Harris, “Blu-ray vs. HD DVD: Game Over,” http://blogs.zdnet.com/storage/?p=149.

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Another tactic for capturing network effects with network ecosystems is to carefully

define the architectural standards enabling connectivity and interoperability and

promote these standards such that the standards become dominant in the network

ecosystem market space. Winning standards wars is critical as this increases the

number and variety of complements available to participants. A primary factor

behind Microsoft’s dominance in PC operating systems was the wide variety of

software applications compatible with the Windows operating system. This reinforces

the dominance of Windows in the market for PC operating systems. Firms become

successful in standards wars either by leveraging their brand and existing market

presence (e.g., a Microsoft, an IBM, an Apple, a Google, etc.) or by forming alliances

with other firms and collectively engaging in persuasive tactics to influence an

industry-wide movement toward a favored standard (e.g., Bluetooth, GSM for

mobility services, Android for smart phones, etc.).

Two-Sided Markets

A key notion for understanding the nature of network ecosystems involves the

economics of two-sided markets.32 With a two-sided market, the ecosystem

owner/builder – the network orchestrator – brings together two distinct communities

to engage in value-unit exchanges. Most typically, this is accomplished by growing

one side of the market as a means of attracting participants to the other side of the

market. The two sides of the network ecosystem are perhaps best thought of as a

subsidy-side and a money-side, with the ecosystem’s market platform providing

32 T. Eisenmann, G. Parker and M. Van Alstyne, “Strategies for Two-Sided Markets,”

Harvard Business Review, October 2006, pp. 92-101.

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the rules, functionalities and resources to attract participants and to facilitate value-

unit exchanges. As a general rule, the subsidy-side is provided incentives to

participate in a network ecosystem as the primary role of the subsidy-side is to attract

the money-side, from which revenues are generated. The basic idea, thus, is to grow

the subsidized community to the point that its size becomes sufficient to attractive

money-side participants willing to pay a fee to gain access to the subsidy-side

participants.

As an example of a two-sided market, consider Figure 6-4, which depicts a

generic job-recruiting network ecosystem, e.g., CareerBuilder, Monster, Job.com,

etc. The subsidy-side is the community of individuals looking for a job. By heavily

subsidizing (free?) participation and by offering useful rules (e.g., privacy),

functionalities (e.g., resume-builder) and resources (e.g., career advice content), a

large pool of job candidates is built. If this pool of job applicants is large and of high

quality (e.g., broad ranges of skills and experiences), a high likelihood exists that a

sizable pool of recruiters will be attracted despite the participation fees being charged

to these recruiters (typically, a recruiter might be charged a modest fee to post a job

opportunity, a slightly larger fee for each match that occurs, and a much larger fee

if and when an applicant is offered a position).

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Figure 6-4 Generic Job Recruiting Network Ecosystem

Applicants

(Consumers of Jobs)

Recruiters

(Producers of Jobs)

Market Platform

Rules Functionalities Resources

Another, quite different, example of a two-sided market involves Adobe and

its Adobe Reader and Adobe Acrobat software (see Figure 6-5). Before Adobe Reader

and Acrobat were released, the established standard for sharing and printing

documents was a tool called PostScript. In order to make inroads into the lucrative

document creation software market, Adobe made its document reader software freely

available (subsidizing the consumers of digital documents) and encouraged adopters

to share information about Adobe Reader and how to obtain it. With positive word-

of-mouth by a large number of Adobe Reader adopters, Adobe Reader became the

de facto standard for document reading and sharing. Once Adobe Reader became

the dominant document reader for viewing any type of document, Adobe was able to

sell its document-creation software, Acrobat, to all types of document creators:

publishers, law firms, authors, etc. While Adobe continues to give Adobe Reader

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away for free, it generates sizeable revenues through its Acrobat software (now

available only by lease, a more-profitable pricing tactic).

Figure 6-5 Adobe’s Two-Sided Market Business Strategy

Consumers of Digital Documents

Producers of Digital Documents

Market Platform

Software Products to Download

User Authentication & Account Management

Payment Systems Customer Support & User Manuals

What is important about Adobe’s strategy? Adobe could have enjoyed the

benefits of network effects by only offering Adobe Reader - by standardizing their use

around it, consumers of digital documents would be able to easily exchange

documents and read them on any type of device. However, would this positive

network effect benefit Adobe to the same extent it benefited Adobe’s customers? In

other words, would Adobe have been able to eventually sell Adobe Reader at a price

sufficient to generate a lucrative profit? What price could it charge without hurting

its ability to build a critical mass of document reader users? Adobe recognized that

rather severe limits existed regarding what people would be willing to pay for a

document reader. But, Adobe also recognized that it could generate substantial

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revenue from document-creation software given that it could achieve a large,

installed base of Adobe Reader users.

Figure 6-6 provides a more nuanced depiction of the logic underlying a two-

sided market. Note that two types of positive network effects are in play. The first

is called the same-side effect and refers to the possibility of network effects with

each side of the market. In the case of Adobe, as more people adopt Adobe Reader

for viewing documents, each is presented with more opportunities to easily share

documents. This represents a positive, same-side network effect for the adopters of

Acrobat Reader. Potential same-side network effects exist, as well, for document

producers. As more producers adopt Adobe Acrobat for document creation, more

opportunities arise for these producers to exchange content in order to create

bundled offerings.

Figure 6-6 Same-Side and Cross-Side Network Effects

Side #2 Side #1

Market Platform

Same-side effect

Cross-side effect

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The second type of positive network effect is called a cross-side effect. This

refers to the potential value that one side derives when there are more participants

on the other side. Again, using the Adobe example, adopters of Adobe Reader benefit

as more producers adopt the Adobe Acrobat document creation software (because of

the increase in the number of compatible digital documents), and document

producers benefit with an increase in the number of consumers reading digital

documents through the use of Acrobat Reader (a larger consumer market for

produced digital documents).

So far, our discussion has been based on the assumption that same-side and

cross-side network effects are always positive. This is not the case, as these network

effects could be negative. Refer back to the job recruiting network ecosystem

portrayed earlier as Figure 6-4. Are the same-side network effects positive or

negative? Does a growing pool of job applicants benefit each applicant participating

in the ecosystem? Does a growing list of recruiters benefit each recruiter participating

in the ecosystem? Possibly not, as this may translate into greater competition among

applicants for the best jobs, as well as greater competition among recruiters for the

best candidates. Even though each side benefits from positive, cross-side network

effects, the potential for negative, same-side network effects could limit the number

of job seekers or job providers willing to participate in the ecosystem.33

33 The way job recruiting network systems typically deal with negative, cross-side

network effects is to segment the pools of available jobs and applicants into ‘sub-markets’

that become more-level playing fields for both recruiters and applicants.

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Multi-Sided Markets

Increasingly, today’s network ecosystems are designed as multi-sided markets

rather than as two-sided markets. A multi-sided market involves more than two

actively participating communities. In this chapter’s introduction, we described a

three-sided market (the Google search network ecosystem) and a four-sided market

(the Facebook social media network ecosystem).

With multi-sided markets, each added community presents an opportunity to

generate additional revenue streams. Facebook, for example, receives revenue from

advertisers and from app producers. But, this potential for increased revenue is

accompanied by three management challenges:

 Creating and then evolving attractive value propositions for each

participating community.

 Identifying and optimizing positive same-side/cross network effects.

 Identifying and minimizing negative same-side/cross effects.

As the number of communities participating in a multi-side network increases, the

complexity of these management challenges tends to increase in a nonlinear fashion.

Winner-Take-All Markets

Increasingly, the payoff gap between being the best competitor in a market

and the second-best is widening into a canyon. This applies to labor markets (e.g.,

professional athletes), to technology markets (e.g., technology producers), and

especially to network ecosystems. In explaining the nature of winner-take-all

markets, we begin with the most straightforward context – that of a digital

product/service.

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As positive network effects drive more consumers to adopt a product or

service, the product/service can gain a critical mass of adopters and become

dominant in its market space. This same phenomenon occurs with network

ecosystems. A critical mass of network ecosystem participants is achieved when the

momentum produced by an ecosystem’s positive network effects is unlikely to be

reversed by the entry into the market space of an appealing new network ecosystem,

regardless of how appealing this new ecosystem’s value-units might be. Think of the

market dominance held by Microsoft Windows and Office, by Google’s Android and

Gmail, and by Blu-ray DVD players and movies. In each of these cases, the

respective markets are said to have tipped over with the winner crowding out rival

products or services. A winner-take-all market, thus, refers to a market where

the potential exists that a critical mass of consumers will adopt one producer’s

products/services.

Nintendo’s entry into the home video gaming market nicely demonstrates how

competition unfolds in winner-take-all markets. In 1985, Atari was the dominant

firm in the video game market. By Christmas 1986, the Nintendo Entertainment

System (NES) had emerged as a very popular product, creating positive network

effects with both customers and, importantly, game developers, in turn attracting

even more customers. At some point, the market tipped over to Nintendo as the

dominant competitor. Once this occurred, game developers were willing to produce

their software exclusively for Nintendo for a two-year period – indicating the

significant rewards winners can obtain in winner-take-all markets. Microsoft’s

business strategies with its operating systems and its Office software suite reflect

similar competitive dynamics.

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Network ecosystems are particularly susceptible to winner-take-all markets.

Three factors tend to characterize winner-take-all network ecosystems:

 Strong producer economies of scale.

 Strong positive cross-side network effects.

 High consumer switching costs.

The latter factor is especially important. When participating in a competitor network

ecosystem is perceived as being costly (i.e., a non-trivial investment is required to

participate in a network ecosystem and this investment is then lost in moving to a

different ecosystem), consumers will be reluctant to either participate in multiple

network ecosystems or to switch ecosystems.

Importantly, not all market spaces are susceptible to winner-take-all market

dynamics. Consider the market space for daily deals, e.g., Groupon and

LivingSocial.34 Many early investors believed that strong cross-side network effects

would produce high stock valuations for Groupon and for LivingSocial. However, as

consumers participating in Groupon and in LivingSocial experienced very low

switching costs, little allegiance was shown to any one market platform with

consumers instead skipping through multiple platforms looking for the most attractive

deals. As one might expect, the high valuations have yet to materialize.

Generally, a market space susceptible to winner-take-all dynamics is most

likely to be seen as a winner-take-all network ecosystem when:

 Participants experience significant, positive network effects.

34 A. Haigu, “Strategic Decisions for Multi-Sided Platforms,” Sloan Management

Review, Winter 2014, pp. 71-80.

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 Participants are reluctant to move to a competing ecosystem.

 One of the network ecosystems begins to attract a majority of the new

participants entering the market space.

 This same ecosystem attracts an accelerating flow of participants from

competing ecosystems.

Competition in early-stage winner-take-all network ecosystem market spaces can be

fierce. More profitable competitors, because they are more profitable, are able to

invest more in R&D and to provide greater incentives to participants - enabling their

participating communities to grow even faster. This intense competition often results

in winner-take-all market spaces being dominated by just a few firms (two or three,

at most).

Crowd-Based Capitalism

The past decade has witnessed a reemergence of bartering, the earliest type

of market-focused ecosystem, in the form of crowd-based capitalism – that is, a

two-sided market that brings together two crowds, or communities, of individuals:

one community possessing an under-used asset or skill (the value-unit) and the other

possessing a short-term need for such an asset or skill. This new bartering ecosystem

differs from the original in two important ways:

 The medium for the short-term sharing of the value-unit is money. In other words, the person that owns the shared value-unit gets paid by the person being granted short-term use of the value-unit.

 The market is enabled through a digitalized market platform built, managed and owned by a third-party, the network orchestrator.

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This form of market-focused ecosystem is the basis for what is popularly referred to

as to as the sharing economy.35 Essentially, digital technologies (e.g., the Internet,

interconnected smart devices, social media, payment systems, trust systems, etc.)

are extending peoples’ options for obtaining goods and services beyond family,

friends, neighborhood stores and national/global retailers toward crowds of

entrepreneurs.

Table 6-1 lists some of the crowd-based network ecosystems that have

emerged over the last decade. As you look over this listing, notice the attributes of

value-units likely to be shared via crowd-based capitalism: low-use and high-value.

Low-use implies unused capacity (of an asset) or idle time (of a skill-provider); high-

value infers that the value-created – the consumer payment subsequently

appropriated and shared by a producer (an asset-owner or skill-provider) and a

network orchestrator – will exceed the costs associated with an exchange.

35 A. Sundararajan, The Sharing Economy: The End of Employment and the Rise of

Crowd-Based Capitalism, MIT Press, Cambridge, MA, 2016.

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Table 6-1 Examples of Crowd-Based Network Ecosystems

Crowd-Based Network Ecosystem

Value-Unit Examples

Educational Services Idle Skill Capacity SkillShare,TradeSchool, Udemy

Freelance Work Idle Expertise Capacity Amazon Mechanical Turk, InnoCentive, TopCoder, Upwork

Fundraising Idle Capital AngelList, FundiingCircle, Kickstarter

Handyman Chores Idle Labor Capacity Handy, TaskRabbit, TimesFree

High-End Fashion Unused Clothes Designer24, Rendevoux, Rent My Wardrobe, Rent the Runway, StyleLand

Lodging Unused Housing Capacity Airbnb, CouchSurfing

Personal Services Idle Labor Capacity Lux, Postmate, Shyp, Washio, Wag

Philanthropy Idle Capital DonorsChoose, Kiva

Transportation Unused Automobile

Capacity BlaBlaCar, Getaround, Lyft, Turo, Uber, Zipcar

Digitalizing Network Ecosystems

Network ecosystems existed prior to the eras of digital disruption. For

example, three pervasive pre-digital network ecosystems were those involving (as

network orchestrators) real estate brokerages, independent insurance agencies and

travel agencies. In these network ecosystems, the network orchestrator (via the

work processes shown in Figure 6-7):

 Built up a portfolio of offerings from a producer community.

 Attracted a consumer community.

 Enriched producers’ offering creation capabilities.

 Enriched consumer demand.

 Matched the needs of individual consumers with the producer’s offerings.

 Facilitated both exchange transactions and exchange fulfillment.

 Worked to retain the members of the producer and consumer communities.

With digitalized network ecosystems, the vast majority of work processes are carried

out through a market platform (i.e., a collection of digital platforms and business

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platforms). The digitization and digitalization reflective of the three eras of digital

disruption (see Table 6-2) have produced two types of effects on network

ecosystems. First, the pre-digital network ecosystems have either radically

transformed themselves through both digitalization and specialization or have exited

their markets. Second, scores of new network ecosystems have emerged and

continue to emerge (see Table 6-3).

Figure 6-7 A Network Orchestrator’s Managerial and Operational Processes

Indirect Materials & Supplies Procurement

Human Resource Recruitment & Development; Benefits Management

Financial Services; Accounting Services

Business/Digital Strategizing; Administrative Services

Matching Consumer Demand

With Producer Supply

Growing a Producer

Community

Growing a Consumer

Community

Transaction Execution Efficiency & Safety

Exchange Fulfillment Execution & Safety

Retaining Producer

Community

Retaining Consumer

Community

S u

p p

o rt

P ro

c e

s s e

s P

ri m

a ry

P ro

c e

s s e

s

R&D; New Services Development; New Services Rollout

Digital Technology Services & Management

Facilitating Producer

Value-Unit Creation

Stimulating Consumer Demand

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Table 6-2 Evolution of Network Ecosystems

Era Value-Units Digitization & Digitalization Exchange Currency

Trust Systems

1 Digital complements

 Data/document standards  Point-to-point connectivity  Intra- and inter-

organizational (managerial and operational) process efficiencies

 Banking system

 Credit/debit card systems

 Government & 3rd- party institutions

 Contracts  Brand  Social capital

2 Digital value- units

 Internet  One-to-many connectivity  Data, process, analytic and

collaboration platforms  Social media  Omni-channel producer-

consumer interaction

 Digitalized payment systems

 3rd-party digital trust seals

 Consumer monitoring (product & producer reviews)

3 Social complements

 Many-to-many connectivity  Smart devices  Big Data platforms  Big Data analytic platforms  Social messaging platforms

 Reputation  Social capital  Bitcoins

 Community monitoring

 Peer-regulation  Self-regulation

Table 6-3 Examples of Network Ecosystems

Era Variation Examples Community 1 Community 2 Community 3

1

Services Platform Visa, MasterCard Producing

Organizations Banks Consumers

Digital Architecture Microsoft’s PC

Operating System Application Producers

PC Producers Consumers

2

B2B Horizontal Marketplace

Alibaba.com, Thomasnet.com

Producing Organizations

Advertisers Consuming

Organizations

B2B Vertical Marketplace

e-Steel, Farms.com

Producing Organizations

Advertisers Consuming

Organizations

B2C e-Commerce Amazon

Marketplace Producing

Organizations Advertisers Consumers

C2C e-Commerce eBay, Craigslist Producers Advertisers Consumers

3

Search Platform Google Content

Producers Advertisers

Content Consumers

Social Media Platform

Twitter Content

Producers Advertisers

Content Consumers

Crowd-Based Capitalism

Airbnb, Uber Asset/Skill

Owner Advertisers

Asset/Skill User

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Era 1

Two types of network ecosystems emerged during Era 1. The first of these

applied proprietary, point-to-point connectivity to create new markets based on

digitalized services. Perhaps the most familiar example is that of credit card

providers, such as Visa and MasterCard. By establishing a digitalized (in part)

services platform, merchants were able to offer a convenient, safe payment channel

to consumers and banks gained a new revenue stream.

The second type of network ecosystem that emerged involved proprietary

architectures for digital products and these product’s complements. By promoting

and licensing a product architecture that tips over a market, the architecture’s creator

is able to sustain high-margin sales for a lengthy period of time. Perhaps the most

familiar example of this is that of personal computer (PC) operating systems, such

as Microsoft OS (and then Windows). The Intel PC operating system market tipped

over to Microsoft OS because the PC application software community gave priority to

developing products to run on OS (and then on Windows) – increasing the likelihoods

that software producers would gain large revenue streams and that consumers

purchasing PCs would be able to run needed software.

Era 2

The availability of one-to-many connectivity enabled by the Internet triggered

a rapid growth in network ecosystems. Four distinct types of e-commerce

ecosystems emerged: B2B horizontal (producers offering a broad range of value-

units to any type of consumer-business) marketplaces, B2B vertical (producers

offering value-units to consumer-businesses in a single industry) marketplaces, B2C

marketplaces, and C2C marketplaces.

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B2B marketplaces generally operate in the upstream portions of industry value

streams. Connecting (raw material and component) suppliers to producers, these

intermediaries aim to disintermediate established supplier-producer relationships

with the promise of a more efficient market. The value-propositions of these B2B

marketplaces vary considerably, as reflected in the four levels of functionality that

can be established between producers and consumers: information exchange, value-

unit exchange/fulfillment transaction execution, logistical flow coordination, and

collaboration enablement.

B2C and C2C marketplaces generally operate in the downstream portions of

industry value chains. Connecting finished goods producers to consumers, these

intermediaries aim to disintermediate established retailer-consumer relationships,

again with the promise of a more efficient market. Notice in Table 6-3 (shown earlier)

that the example given for an Era 2 B2C network ecosystem is Amazon Marketplace

rather than Amazon, given Amazon Marketplace’s objective of bringing together a

broad community of small producers to interact with Amazon’s consumer community.

Two examples of C2C marketplaces, eBay and Craigslist, are used to illustrate the

variety that exists. For example, eBay utilizes an auction pricing mechanism and

offers the parties of value-unit exchanges a range of transactional and fulfillment

services, while Craigslist utilizes fixed prices and offers little in the way of

transactional and fulfillment services.

Era 3

The digital technologies associated with the third era of digital disruption –

most notably many-to-many connectivity, smart devices, social messaging and peer

regulation – triggered a fresh, explosive wave of network ecosystems focused on

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enabling and exploiting individuals’ desires to maintain anytime, anywhere

connections with the people, institutions and opportunities that are most important

to them. As listed earlier in Table 6-3, the dominant types of Era 3 network

ecosystems involve digital services (e.g., search, photo sharing, music sharing, etc.),

social media, and crowd-based capitalism. As many of these network ecosystems

involve participants and activities outside of the purview of established markets and

institutions, new forms of community-based and peer-based trust systems have

emerged. For example, there are limited regulations at present to assure consumers

of the accuracy of host-provided Airbnb lodging descriptions. In response, Airbnb

has implemented two trust mechanisms: the capturing and reporting of consumers’

lodging reviews, and host identity verification systems that combine the digitized

social capital of social media with governmental ID infrastructures. In addition,

Airbnb proactively involves hosts and consumers in developing and evolving

standards and expectations guidelines that must be agreed-to by hosts and

consumers.

Blended Organizations

Today’s most successful organizations are increasingly exhibiting the qualities

of both pipeline ecosystems and network ecosystems, and in the process becoming

a blended organization. This primarily occurs via one of two approaches:

 An organization operates multiple, largely independent business models,

some of which are executed as a pipeline organization and others as a network organization.

 A pipeline organization incorporates a private or semi-private network- ecosystem as a means of enhancing efficiency, effectiveness or both.

Each of these approaches is briefly described.

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The organization that best illustrates the first approach of operating both

pipeline ecosystem and network ecosystem business models is Amazon. Amazon’s

initial business model was that of a pipeline ecosystem retailer: interacting physically

with suppliers to stock product inventories, then interacting digitally with customers

to sell these products, and then interacting physically and digitally with third-party

package delivery providers in fulfilling customers’ purchases from Amazon’s brick-

and-mortar distribution centers. Over time, Amazon has expanded its portfolio of

business models to include operating as:

 A pipeline ecosystem retailer that stocks, sells and delivers digital products

and smart devices.

 A pipeline ecosystem producer of digital technology services for businesses

and for individuals.

 A network ecosystem orchestrator of media streaming services.

 A network ecosystem orchestrator of B2B and B2C marketplaces.

While Amazon’s various business models are targeted at distinct markets, they all

make extensive use of Amazon’s world-class capabilities to design, build, operate and

evolve digital platforms and business platforms.

The second approach to becoming a blended organization involves a focus on

upstream, internal and/or downstream processes.

With regard to upstream processes, for many producers (e.g., automobiles,

durable appliances, electronic products, etc.) a few of the raw materials used in

procured components represent a significant percentage of production costs. Part A

of Figure 6-8 portrays a traditional upstream value stream for a pipeline

manufacturing organization. Note that value stream participants engage with two

largely-independent markets: Market 1 involves raw material suppliers and

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component suppliers, and Market 2 involves these component suppliers and the

producers. Because of the potential for supply/demand imbalances and information

asymmetries, component suppliers tend to be disadvantaged in Market 1, passing on

market inefficiencies to the manufacturer in the form of higher prices and logistical

delays in Market 2. Part B of Figure 6-8 introduces the notion of a supply hub as a

means of overcoming these potential market inefficiencies in this upstream portion

of the traditional pipeline value stream.36 Here, the manufacturer creates a pseudo-

market (Market 3) within the established market for raw materials. After aggregating

raw material requirements and production plans across all component suppliers, a

producer is able to apply a comprehensive understanding of component supplier

demand (volumes and timings) in negotiating prices with raw material suppliers on

behalf of the component suppliers.

36 A. Agrawal, A. De Meyer and L.N. Van Wassenhove, “Managing Value in Supply

Chains: Case Studies on the Sourcing Hub Concept,” California Management Review, Winter

2014, pp. 23-54.

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Figure 6-8 Introducing a Supply Hub into a Pipeline Ecosystem Value Stream

Component Suppliers

Markets

Raw Material Suppliers

Producer Component Suppliers

Markets

Raw Material Suppliers

Producer

A. Traditional Value Stream B. Raw Material Supply Hub

1 2

3

With regard to internal processes, organizations can obtain a variety of benefits

(e.g., productivity, employee goodwill, reputation enhancement, etc.) by employing

a private network ecosystem solely inside their boundaries. The platforms used with

such internal marketplaces can be developed in-house or licensed from a third-party

platform-provider. A nice example of using a private market ecosystem is that of

Zimride, the ride-sharing platform that Lyft’s founders licensed to universities and

businesses as a private ride-sharing service used solely by a subscribing

university’s/business’s employees.37 Zimride provides a useful benefit for employees

in the form of a convenient and safe mechanism for solving employees’ commuting-

to-work problems and positions the organization as being socially-responsible, a

quality likely valued by many of the organization’s stakeholders.

37 R. Lawler, “Lyft-Off: Zimride’s Long Ride to Overnight Success,” TechCrunch, August

29, 2014: https://techcrunch.com/2014/08/29/6000-words-about-a-pink-mustache/

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With regard to downstream processes, Table 6-4 provides examples of three

organizations that have appended C2C marketplaces as complements to their

traditional sales channels. When carefully conceived and executed, the network

effects engendered can be exploited to enrich a brand and grow the consumer base

without cannibalizing pre-existing sales channels.

Table 6-4 Introducing a C2C Marketplace into a Pipeline Ecosystem Value Stream

Pipeline Organization

Network Ecosystem Strategic Value

Ikea Group Ikea Family loyalty program community: members post & sell used Ikea items.

 Supports Ikea’s eco-friendly ethos.

 Opens up room in members’ homes for new Ikea items.

Patagonia Partnership with eBay: consumers easily sell used Patagonia clothing items.

 Supports Patagonia’s eco-friendly ethos.

 Increases the visibility of the Patagonia brand both online and on the street.

DM (German

Drugstore Chain)

Sponsors & arranges clothing swap events, at which makeup/styling products & techniques are demonstrated.

 Generates new consumers in the targeted demographic.

 Enriches brand by leveraging the green spirit of sharing rather than buying.

 Gains brand visibility as these events are featured on social media and by fashion bloggers.

A Recap and Look Ahead

Network ecosystems, as introduced and fleshed out in this chapter, represent

a rapidly increasing segment of most countries’ GNPs. In the process, existing

markets and industries are being transformed and new markets and industries are

being formed. The next chapter examines the digital strategy formulation process

for network orchestrators, regardless if a network orchestrator offers a market

platform for a public or private network ecosystem.

GLOSSARY

Blended organization – an organization that operates, to varying extents, as both

a pipeline organization and a network organization.

Complement – an entity that increases the perceived worth of a value-unit.

Core transaction – the primary market exchange activity driving both producers and consumers to an ecosystem’s market platform.

Critical mass – the point at which the number of product/service-adopters results

in the product/service becoming dominant within its market space.

Cross-side effect – existence of positive (or negative) effects felt by a community

associated with a network ecosystem as the number of members increases with another of the ecosystem’s communities.

Crowd-based capitalism – a two-sided market that brings together two crowds, or

communities, of individuals: one community possessing an under-used asset or skill (the value-unit) and the other possessing a short-term need for such an asset or

skill.

Market platform – the organized collection of digital and business platforms that hosts the content and functionalities that establish, operate and govern the

ecosystem’s market.

Money-side – a revenue-generating community associated with a network

ecosystem.

Multi-sided market – a network ecosystem with more than two actively

participating communities.

Network effects – where the worth of or demand for a value-unit grows as an exponential function of the number of current consumers of a value-unit and/or the

number of complements available to these consumers.

Network externality – where the worth of or demand for a value-unit grows as an

exponential function of the number of current consumers of a value-unit and/or the number of complements available to these consumers.

Same-side effect – existence of positive (or negative) effects within a community

associated with a network ecosystem.

Subsidy-side – an incentivized community associated with a network ecosystem.

The sharing economy – an economy driven by crowd-based capitalism.

Two-sided market – a network ecosystem in which a producer community and a consumer community are brought together to engage in value-unit exchanges.

Winner-take-all-market – a market where the potential exists that a critical mass of consumers will adopt one producer’s products/services.